No company ever wants to go through a restructuring or liquidation process. Those that are able to recognise the early warning signs of financial trouble can take action to address the issues early on and possibly avoid restructuring or liquidation.

Restructuring can be defined very broadly. The company in debt need not be insolvent, but may have liquidity or balance sheet problems or many be unable to demonstrate its ability to cover its financial obligations. Restructuring should preferably be implemented at an early stage when there will be more options available to improve the financial position of the company or its business.

There are many potential early impairment warning signs that companies should recognise. These warning signs can be split into three separate categories - event driven; company and industry driven; and financial market driven signs.

If multiple amendments are being made to credit agreements and there are covenant defaults, these are early event-driven warning signs that the company may be financially impaired. Credit rating downgrades and/ or going concern audit opinions are also warning signs that action should be taken to restore the financial position of the company as soon as possible. If a company’s CFO resigns unexpectedly, this may also be an indication that all is not  well.

Company and industry driven early warning signs can include general deteriorating industry conditions that are effecting the sector as a whole, but perhaps being experienced more severely by a specific company. If financing sources are exiting the business sector, this will also add pressure. Payables becoming stretched and the loss of the ability to factor receivables may be further warning signs that the company may be financially impaired.

Other company or industry driven warning signs may include the imbalance of assets and liabilities for cash flow purposes, multiple board resignations, large-scale litigation or regulatory enforcement actions, significant cap-ex / investment requirements and restrictive/ above market leases and key agreements. If any of these issues arise, creditors should seek to engage with the company, where possible, to rectify the impairment.

Financial market driven early warning signs include, for example, instances where debt is maturing in the near future (less than 18 months) for a highly leveraged company and such debt has not been refinanced. If bond or bank debt prices decline or bank debt becomes owned by hedge funds and non-relationship banks, then this can be taken as indication that a restructuring might be possible, or at least that market sentiment suggests that the company is a target for restructuring.

If debtor companies and creditors take heed of the early warning signs, they may be able to resolve issues in an efficient and time effective manner and avoid potentially severe restructurings or, worse, liquidations. It is recommended that these early warning signs are never ignored. Whilst restructuring may be unpleasant it is far better for all stakeholders - the debtor, creditors and employees - than liquidation.

Author: Lyndon Norley, consultant at Bowmans